Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, March 27, 2009

Three Defendants in Insider Trading Ring Settle Charges

On March 26, 2009, the United States District Court for the Southern District of New York entered final consent judgments against defendants Nickolaus Shuster, Juan C. Renteria, Jr. and Monika Vujovic, in an action filed in 2005 by the Commission, charging 17 defendants with collectively engaging in a insider trading scheme, which netted almost $7 million in illicit gains, through trading in at least 26 stocks.  The SEC alleged that Shuster and Renteria were hired by the two primary architects of the insider trading schemes, David Pajcin and Eugene Plotkin, to obtain jobs at Quad/Graphics, Inc., a printing plant for BusinessWeek magazine. Shuster and Renteria would call Pajcin and Plotkin, and read them key portions of the "Inside Wall Street" column — a widely-read column that generally moves the price of the securities of companies mentioned in it — prior to the time the column was made available to the public. As a result of the information provided, Pajcin and Plotkin traded in, and/or tipped others with material non-public information concerning at least 10 companies, resulting in collective ill-gotten gains of approximately $280,000. Pajcin and Plotkin paid Renteria approximately $5,000 and paid Shuster approximately $20,000 for the information. The Court entered orders permanently enjoining both Shuster and Renteria from further violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

As alleged by the SEC, Vujovic, who was dating Pajcin at the time, allowed Pajcin to open a brokerage account in her name at Ameritrade, Inc. and to engage in insider trading through that account in order to avoid detection. Pajcin executed trades from this account based on material non-public information he received stemming from BusinessWeek, as well as Merrill Lynch, collectively making over $314,000 in ill-gotten gains. The Court entered an order permanently enjoining Vujovic from further violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and further found Vujovic liable to pay disgorgement of $261,364.12, to be satisfied by payment of all funds in a brokerage account held in Vujovic's name at TD Ameritrade, Inc., which had been frozen since 2005 pursuant to a Court order.

March 27, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, March 26, 2009

GAO Reports on SEC Oversight of Clearing Agencies

Geithner Testifies on Regulatory Reform

Here is Treasury Secretary Tim Geithner's Written Testimony before the House Financial Services Committee Hearing today, and here is Framework for Regulatory Reform that Treasury also released.

March 26, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA's Ketchum and NASAA's Joseph Testify Before Senate Banking Committee

Richard G. Ketchum, Chairman and Chief Executive Officer, FINRA, testified today before the Senate Committee on Banking, Housing, and Urban Affairs, as did Fred J. Joseph, Colorado Securities Commissioner and President, NASAA.

March 26, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Schapiro Testifies Before Financial Services on Enhancing Investor Protection

SEC Chairman Mary L. Schapiro testified today on Enhancing Investor Protection and Regulation of the Securities Markets before the United States Senate Committee on Banking, Housing and Urban Affairs.

March 26, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Obtains Emergency Freeze Against Millennium Bank Alleging Ponzi Scheme

Another day -- another Ponzi scheme:

The SEC obtained an emergency court order halting a $68 million Ponzi scheme involving the sale of fictitious high-yield certificates of deposit (CDs) by Caribbean-based Millennium Bank.  The SEC alleges that the scheme targeted U.S. investors and misled them into believing they were putting their money in supposedly safe and secure CDs that purportedly offered returns that were up to 321 percent higher than legitimate bank-issued CDs. The SEC's complaint alleges that William J. Wise of Raleigh, N.C., and Kristi M. Hoegel of Napa, Calif., orchestrated the scheme through Millennium Bank, its Geneva, Switzerland-based parent United Trust of Switzerland S.A., and U.S.-based affiliates UT of S, LLC and Millennium Financial Group. In addition to Wise and Kristi Hoegel and these entities, the SEC has charged Jacqueline S. Hoegel (who is the mother of Kristi Hoegel), Brijesh Chopra, and Philippe Angeloni for their roles in the scheme.

Judge Reed O'Connor, in the U.S. District Court for the Northern District of Texas, granted the SEC's request for an asset freeze and emergency relief for investors.

Additionally, the SEC's complaint names four individuals and four entities as relief defendants: Lynn P. Wise of Raleigh, N.C. (the wife of William J. Wise); Ryan D. Hoegel of Lincoln, Calif. (the brother of Kristi Hoegel); Daryl C. Hoegel of American Canyon, Calif. (the husband of Jacqueline Hoegel), Laurie H. Walton of Raleigh; and United T of S, LLC, Sterling I.S., LLC, Matrix Administration, LLC, and Jasmine Administration, LLC. All four entities are based in Las Vegas. The SEC's enforcement action seeks an order compelling them to return funds and assets traceable to the Millennium Bank fraud.

March 26, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Wednesday, March 25, 2009

SEC's Inspector General Recommends Improved Procedures for Handling Complaints about Naked Short Selling

The SEC's Office of Inspector General recently released a report on Practices Related to Naked Short Selling Complaints and Referrals, in which it examines the SEC Enforcement Division's procedures relating to naked short selling.  The Report explains that Enforcement has received a great deal of complaints during the past several years from issuers and investors about “naked” short selling, which has become an issue of increasing concern to both issuers of securities and investors. Many complaints requested that Enforcement investigate specific instances of naked short selling. Other complaints concerned the perceived failure on the part of the Commission and others, including Enforcement, to address the harmful effects of naked short selling.  In addition, the the SEC’s Office of Inspector General (OIG) has also received numerous complaints, particularly since December 2007, alleging that Enforcement has failed to take sufficient action regarding naked short selling. Many of these complaints asserted that investors and companies lost billions of dollars because Enforcement has not taken sufficient action against naked short selling practices. These complaints further indicated a lack of confidence on the part of some members of the public in Enforcement’s ability to protect investors.

In light of these complaints and based on our audit plan, we conducted an audit to assess whether Enforcement:
Established policies and guidelines that enabled Enforcement to respond appropriately to complaints and referrals, including those involving naked short selling; and
Followed existing policies and procedures for responding to complaints and referrals, including those pertaining to naked short selling.

Our audit disclosed that despite the tremendous amount of attention the practice of naked short selling has generated in recent years, Enforcement has brought very few enforcement actions based on conduct involving abusive or manipulative naked short selling.

...during the period of our review we found that few naked short selling complaints were forwarded to Headquarters or Regional Office Enforcement staff for further investigation.

The Report concludes with a series of recommendations to improve Enforcement's procedures in handling complaints about naked short selling.

March 25, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

E&Y Settles HealthSouth Accounting Fraud Charges for $109 Million

Ernst & Young, HealthSouth's auditor from 1996-2002, agreed to pay $109 million to settle accounting fraud charges brought by HealthSouth investors.  UBS previously settled similar charges for $100 million.  Richard Scrushy, HealthSouth's CEO at the time, was acquitted of accounting fraud charges, although subsequently convicted on fraud and bribery charges., E&Y Settles HealthSouth Case for $109M.

March 25, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Morgan Stanley for Improper Retirement Advice to Kodak and Xerox Employees

FINRA announced that it fined Morgan Stanley & Co. $3 million — and ordered it to pay more than $4.2 million in restitution to 90 Rochester, NY-area retirees — to resolve charges that its supervisory system failed to detect and prevent brokers from persuading Eastman Kodak Company and Xerox Corporation employees to take early retirement based upon unrealistic promises of consistently high investment returns and by espousing unsuitable investment strategies.  FINRA found that Morgan Stanley failed to reasonably supervise the activities of Michael J. Kazacos and David M. Isabella, two former registered representatives in its Rochester branch office. FINRA has permanently barred Kazacos from the securities industry for committing numerous violations of FINRA rules in connection with his solicitation and handling of IRA rollover/retirement accounts, such as making unrealistic predictions that customers would earn investment returns of 10 percent each year.

 In a formal disciplinary complaint filed today, FINRA charged Isabella with having engaged in similar misconduct. The matter will be adjudicated before a three-member FINRA Hearing Panel. FINRA also found that Ira S. Miller, the manager of Morgan Stanley's Rochester branch, failed to reasonably supervise both representatives. Miller was fined $50,000, suspended from acting in a principal capacity for one year and ordered to re-qualify as a principal before serving in such capacity in the future.

 FINRA found that as a result of the misconduct at least 184 customers suffered financial hardships, including market losses, a reduction in principal and the inability to sustain expected withdrawal rates. In many cases, the customer's initial investment was eroded by market declines and the customer's monthly withdrawals were not funded by income but were really distributions of principal. Some customers were forced to return to work at a greatly reduced income in order to meet their basic living expenses. FINRA has ordered Morgan Stanley to pay restitution to 90 former customers of Kazacos or Isabella who sustained losses. The firm has previously settled with 101 other customers of those brokers. 

As to Isabella, a former Xerox employee, FINRA charged that from 2000 through 2003, he solicited many of that company's retirees and potential retirees to invest with him at Morgan Stanley. Isabella allegedly represented to prospective customers that, if they invested their retirement money with him, they would earn approximately 10 percent returns or more each year and be able to satisfy their income needs by withdrawing a consistent amount of money each year without reducing their principal.

In addition to the violations above, FINRA charged Isabella with falsifying records concerning the financial situations and goals of his customers. FINRA also alleged that, in exchange for various gifts to certain Xerox employees, Isabella improperly obtained confidential employment records regarding, among other things, the retirement status of prospective customers employed by Xerox. He utilized this confidential information to attract new customers. FINRA further alleged that, in communicating with prospective customers, Isabella used a professional designation — Retirement Planning Specialist — that he did not actually possess. Finally, FINRA charged Isabella with providing false testimony during its investigation.

 FINRA found that Morgan Stanley failed to enforce a reasonable supervisory system to ensure that Kazacos and Isabella provided customers with appropriate risk disclosures concerning their retirement accounts. During the relevant time period, Kazacos and Isabella generated approximately $15.4 million in gross commissions. The firm knew or should have known that these representatives were actively marketing their early retirement programs to retirees and potential retirees. Nevertheless, the firm failed to take reasonable steps to ensure, among other things, that customers received proper risk disclosures and that Kazacos and Isabella did not promise or promote unrealistic investment returns. FINRA further found that Morgan Stanley also failed to ensure that the securities and accounts that those representatives recommended for the retirees, such as variable annuities and fee-based managed accounts, were properly reviewed for suitability and other concerns.

 FINRA also found that Miller failed to take appropriate action to reasonably supervise Kazacos and Isabella to prevent their unsuitable investment recommendations and failures to disclose risks to many customers.

 In settling these matters, Morgan Stanley, Kazacos and Miller neither admitted nor denied the findings, but consented to the entry of FINRA's findings.

 Under FINRA rules, a firm or individual named in a complaint, such as Isabella, can file a response and request a hearing before a FINRA disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, disgorgement of gains associated with the violations, and payment of restitution. The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint.

March 25, 2009 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

SEC's Chief Accountant Testifies on Increased Credit Availability & Prudent Lending Standards

James L. Kroeker, the SEC's Acting Chief Accountant, testified today on Testimony Concerning Exploring the Balance Between Increased Credit Availability and Prudent Lending Standards before the House Committee on Financial Services.

March 25, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Obtains Preliminary Injunction Against West Virginia-Based Ponzi Scheme

The SEC announced that on March 23, 2009, the federal district court in the Western District of Virginia entered a preliminary injunction order, by consent, against John M. Donnelly, Tower Analysis, Inc., Nasco Tang Corp., and Nadia Capital Corp.  The preliminary injunction restrains Donnelly and the other defendants from violating certain antifraud provisions of the federal securities laws. Also by consent, Judge Conrad ordered that the defendants' and relief defendants' assets remain frozen until further notice, except for a carve-out to provide one relief defendant with reasonable living expenses. The preliminary injunction order continues the relief originally obtained on March 11, 2009, in response to the Commission's emergency civil injunctive action that sought a temporary restraining order, an order freezing assets, disgorgement and civil penalties, and other relief against Donnelly and the other defendants based on their alleged violations of the federal securities laws.

The Commission's complaint alleges that from at least 1998, Donnelly fraudulently obtained at least $11 million from as many as 31 investors through the sale of securities in the form of limited partnership interests in three investment funds. The complaint alleges that Donnelly told investors that he would pool their funds to invest in, among other things, stock and bond index derivatives. According to the complaint, despite representations to investors that he had generated annual returns of as much as 22%, Donnelly has done almost no securities trading. The complaint alleges that instead of using investor funds to execute trades, Donnelly used investor funds to repay other investors, and paid himself approximately $1 million in salary and fees during the last three years alone. The preliminary injunction enjoins Donnelly and the other defendants from violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The defendants consented to the preliminary injunction and continued assets freeze, without admitting or denying the SEC's allegations.

March 25, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Obtains Asset Freeze Against Chicago-Based Investment Advisor

The SEC announced that on March 24, it obtained emergency relief against investment adviser The Nutmeg Group, LLC, and its principals Randall and David Goulding. In its complaint, filed March 23, the Commission alleges that Nutmeg, which controls and provides investment advice to 13 investment funds, and advises two additional investment funds, has misappropriated client assets, made misrepresentations to its clients, failed to comply with its custodial obligations and failed to keep required books and records.  According to the complaint, Nutmeg and the Gouldings misappropriated over $4 million in client assets by transferring them to third parties.  Based on the Commission's allegations, the United States District Court for the Northern District of Illinois entered an order (TRO) temporarily enjoining Nutmeg from violating provisions of the Investment Advisers Act of 1940 and freezes Nutmeg's assets.

 In addition to the emergency relief already obtained, the SEC is seeking preliminary and permanent injunctions and disgorgement against all defendants, and civil penalties against Nutmeg and Randall Goulding. The lawsuit also seeks disgorgement from relief defendants David Goulding, Inc., David Samuel, LLC, Financial Alchemy, LLC, Philly Financial, LLC, Samuel Wayne and Eric Irrgang. The matter is ongoing.

March 25, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 24, 2009

Bernanke and Geithner Testify Before Financial Services on AIG

Both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner testified today before House Financial Services Committee on AIG and those bonuses.

March 24, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Wachovia for Customer Notification Violations

FINRA announced that it fined Wachovia Securities, LLC and First Clearing, LLC, both of St. Louis, MO, $1.1 million for the firms' failure to provide more than 800,000 required notifications to customers over a five-year period ending in 2008. As a part of the settlement with FINRA, the firms are required to retain an independent consultant to review their supervisory systems and processes.   At the time of the activity at issue, Wachovia Securities and First Clearing were both subsidiaries and non-bank affiliates of Wachovia Corporation. On Dec. 31, 2008, Wachovia Corporation was acquired by Wells Fargo & Company.

FINRA found that the failures by Wachovia Securities and First Clearing were the result of various computer programming and operational problems that went undetected by the firms' internal controls procedures and supervisors. Those failures included over 300,000 notifications of changes in investment objectives and approximately 340,000 notifications of changes of address.

FINRA also found that First Clearing failed to send notifications of the existence of clearing agreements to over 54,000 customers and failed to send required margin disclosure statements to more than 50,000 customers. First Clearing also failed to provide customers with trade confirmations for certain bond transactions that accurately reflected the ratings of bonds; failed to provide required information to holders of certain debt, including information about partial call notifications; and, failed to send notifications to customers about certain asset transfers.  In addition, FINRA found that Wachovia Securities and First Clearing failed to have written policies or procedures in place relating to the required notifications and failed to assign supervisory review for various automated mailing systems. FINRA found that the violations went undetected because of the firms' failure to implement appropriate internal controls and testing. FINRA also found that Wachovia Securities and First Clearing failed to establish adequate supervisory systems and procedures relating to the required notifications.

 In settling these matters, Wachovia Securities and First Clearing neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

March 24, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Freezes Assets in Alleged Oil and Gas Scam

The SEC charged a Los Angeles man and two of his companies with securities fraud and obtained an emergency court order to freeze their assets and halt an alleged ongoing oil and gas investment scheme they have been operating out of a boiler room in Los Angeles.

According to the SEC’s complaint, Clement Ejedawe, a/k/a Clement Chad and his companies, Innova Energy LLC and Innova Leasing and Management, raised at least $1.3 million from over 30 investors by promising guaranteed returns on working interests in oil and gas leases or oil and gas drilling equipment. In fact, according to the SEC’s complaint, the defendants did not use investor funds for the oil and gas business but rather to pay Ejedawe’s personal expenses.  According to the complaint, Ejedawe is the subject of at least seven separate cease-and-desist or desist-and refrain orders relating to his unregistered offerings of securities, including orders from California, Alabama, Pennsylvania, Maryland, Kansas, and Washington. Defendants both misrepresented and failed to disclose these state orders to prospective investors.

The SEC obtained an order (1) freezing the assets of Innova Energy, Innova Leasing and Management, and Ejedawe; (2) requiring accountings; (3) prohibiting the destruction of documents; and (4) granting expedited discovery; and (5) temporarily enjoining the Innova entities and Ejedawe from future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. A hearing on whether a preliminary injunction should be issued against the defendants is scheduled for April 6, 2009. The SEC also seeks permanent injunctions, disgorgement, and civil penalties against Ejedawe and the Innova entities.

March 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Managing Director at San Francisco Brokerage Firm Consents to SEC Fraud Charges

The SEC filed today a civil injunctive action in federal district court in San Francisco against David "Scott" Cacchione, a former Managing Director at San Francisco-based brokerage firm Merriman Curhan Ford & Co. ("Merriman"), alleging that he helped a friend bilk banks and private lenders out of approximately $45 million in 2007 and 2008. The SEC alleges that Cacchione provided Silicon Valley venture capitalist William J. "Boots" Del Biaggio III with Merriman customer account statements, which Del Biaggio doctored and used as collateral to obtain fraudulent loans. In the action, the SEC also charged Cacchione with defrauding his own customers by purchasing risky penny stocks in their accounts without their permission.

Cacchione, without admitting or denying the complaint's allegations, has agreed to a permanent injunction from violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. In addition, Cacchione has consented to the institution of public administrative proceedings against him in which he will be barred permanently, pursuant to Section 15(b) of the Exchange Act, from working as a registered representative at a brokerage firm. Finally, Cacchione also has agreed that, at a later date, the court in this matter shall determine the amount of ill-gotten gains (disgorgement) and civil monetary penalties that Cacchione will be required to pay.

The SEC sued Del Biaggio in December 2008 in an action titled Securities & Exchange Commission v. Del Biaggio, CV-08-5450 CRB (N.D. Cal. Dec. 4, 2008). A final judgment, by consent, was entered where Del Biaggio was permanently enjoined from further violations of the antifraud provisions of the federal securities laws. In a separate settled administrative proceeding, the SEC permanently barred Del Biaggio from serving as an investment adviser. Also in December 2008, the U.S. Attorney's Office filed criminal charges against Del Biaggio. Del Biaggio pled guilty to the criminal charges in February 2009 and is expected to be sentenced on June 10, 2009.

Separately today, the U.S. Attorney's Office for the Northern District of California (USAO) also filed criminal charges against Cacchione arising from some of the same conduct that is alleged in the Commission's complaint.

March 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Announces Panelists for Credit Rating Agencies Roundtable

The SEC announced the expected panelists for its April 15 roundtable relating to its oversight of credit rating agencies.  The roundtable will be held at the SEC's Washington, D.C., headquarters and will begin at 10 a.m. ET with opening remarks from SEC Chairman Mary L. Schapiro.  Discussion topics will include issues related to recent SEC rulemaking initiatives, such as conflicts of interest, competition, and transparency. The roundtable will consist of four panels.

Roundtable participants will include leaders from investor organizations, financial services associations, credit rating agencies, and academia.

10:10 a.m. — Panel One: Current NRSRO Perspectives: What Went Wrong and What Corrective Steps Is the Industry Taking?
Daniel Curry, DBRS
Sean Egan, Egan-Jones Ratings
Stephen Joynt, Fitch Ratings
Raymond McDaniel, Moody's Investor Service
Deven Sharma, Standard & Poor's

11:30 a.m. — Panel Two: Competition Issues: What are Current Barriers to Entering the Credit Rating Agency Industry?
Ethan Berman, RiskMetrics Group
James H. Gellert, RapidRatings
George Miller, American Securitization Forum
Frank Partnoy, University of San Diego
Alex Pollock, American Enterprise Institute
Damon Silvers, AFL-CIO
Lawrence J. White, New York University

1:15 p.m. — Panel Three: Users' Perspectives
Deborah A. Cunningham, Securities Industry and Financial Markets Association
Alan J. Fohrer, Southern California Edison
Christopher Gootkind, Wellington Management
James Kaitz, Association of Financial Professionals
Kurt N. Schacht, CFA Institute
Bruce Stern, Association of Financial Guaranty Insurers
Paul Schott Stevens, Investment Company Institute

2:45 p.m. — Panel Four: Approaches to Improve Credit Rating Agency Oversight
Richard Baker, Managed Funds Association
Jörgen Holmquist, European Commission
Mayree C. Clark, Aetos Capital
Joseph A. Grundfest, Stanford Law School
Glenn Reynolds, CreditSights
Stephen Thieke, Group of Thirty

March 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, March 23, 2009

Ketchum's Remarks on Risk Management

An excerpt from remarks by Richard G. Ketchum, Chairman & Chief Executive Officer, Remarks From the SIFMA Compliance & Legal Division's Annual Seminar:

   Let's talk about risk management.

 Several months ago on CNBC, John Gutfreund was asked about the leverage ratios employed by Solomon Brothers under his watch as the head of that organization. He replied that leverage ratios of eight to one gave him heart palpitations. Whatever the accuracy of that assertion, there is no question that leverage ratios rose to unsustainable heights and were rationalized under the banner of the more efficient use of capital. When the system is so leveraged and that leverage begins to unwind, then credit freezes, contract settlements cease, and no institution of any size in terms of revenue, cash flow or capital is safe—especially if that institution is dependent upon external sources of funding, which is the very nature of financial service institutions.

 And, of course, it wasn't only leverage itself, but also the nature of the assets being leveraged. A certain amount of financial hubris set into the belief that modeling risk essentially crowded out, what people now term in various ways—as "black swans," "idiosyncratic risk" or "fat tails." Whatever term you may use, it is the consideration of what happens when that portion of risk at the tail end of the curve happens to manifest. We also now understand correlational risk as perhaps never before—the risk that if there is a two percent modeled risk of default in an asset, the occurrence of that event substantially causes the market in that entire asset class to cease to exist. It is ongoing in an ever more complex financial world.

 In my short time in the industry, I participated in risk management exercises, and let me emphasize that I understand just how difficult that process is. But the painful lessons learned from the last 18 months cannot be forgotten. I will leave to the SEC and Fed to determine how leverage and capital requirements must be adjusted, but changes in the risk management process is equally important. First, scenario analyses need to be performed by independent risk managers that are not in love with the positions or the strategies. Second, scenarios must always evaluate cross-asset contagion risk. Third, the firm must react immediately when there are dramatic market and economic changes to reevaluate the exposures and maximum potential losses, with a careful appreciation of funding implications resulting from holding company exposures and careful concern as to how customers are being advised. And finally, this must be a task that is not delegated by the CEO and senior management of the broker-dealer no matter what the press of other business. Beyond each of these points, compliance must be an active participant in this process. The artificial border between risk management and compliance must end. No, you can't run the numbers, but your instincts and natural concerns regarding impacts on your customers are critical to effective risk management oversight.

 Similar to risk management, there are critical lessons learned for the compliance function rising from the market collapse and credit crisis. The classic example of this, of course, is the auction rate securities market. Investors didn't lose money simply because of a compliance failure on the part of firms, but the impending scarcity of new buyers at auction was, at some point, not a real secret.

 What is clear from the recent experience with auction rate securities is that every broker-dealer must understand the risk-reward quotient of products and that understanding must extend from the product originator to the furthest down-line firm marketing the product. Product review cannot be a static process and firms must understand when market forces render a change in the risks of a product at the earliest reasonable time.

 If we've learned anything from the ARS episode, it's that senior management at firms must be involved in compliance. Compliance officers need to have access to senior leaders and there needs to be a genuine demonstration in responding to potential problems, investing in technology solutions and, most important, providing adequate staffing in the area of compliance.

March 23, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Former Mercury Interactive CFO Settles Backdating Charges with SEC

The SEC today settled civil fraud charges against Sharlene Abrams, a former Chief Financial Officer of Mercury Interactive, LLC, arising from an alleged scheme to backdate stock option grants and from other alleged misconduct.  The SEC previously charged Abrams and three other former senior Mercury officers with perpetrating a fraudulent and deceptive scheme from 1997 to 2005 to award themselves and other Mercury employees undisclosed, secret compensation by backdating stock option grants and failing to record hundreds of millions of dollars of compensation expense. The Commission's complaint alleges that during this period certain of these executives, including Abrams, backdated stock option exercises, made fraudulent disclosures concerning Mercury's "backlog" of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses.

Without admitting or denying the allegations in the Commission's complaint, Abrams consented to the entry of a final judgment permanently enjoining her from violating and/or aiding and abetting violations of the antifraud, financial reporting, record-keeping, internal controls, false statements to auditors, securities ownership reporting and proxy provisions of the federal securities laws, and barring her from serving as an officer or director of a public company. Abrams will pay $2,287,914 in disgorgement, of which $1,498,822 represents the "in-the-money" benefit from her exercise of backdated option grants, and a $425,000 civil penalty. Under the terms of the settlement, Abrams' disgorgement of her "in-the-money" benefit—$1,498,822—would be deemed satisfied by her previous voluntary payment of that amount to Mercury. The settlement is subject to the approval of the United States District Court for the Northern District of California.

As part of the settlement, and following the entry of the proposed final judgment, Abrams, without admitting or denying the Commission's findings, has consented to the entry of Commission order, pursuant to Rule 102(e)(3) of the Commission's Rules of Practice, suspending her from appearing or practicing before the Commission as an accountant.

The Commission previously filed settled charges in this matter against Mercury and three former outside directors of Mercury. On May 31, 2007, the Commission filed civil fraud charges against Mercury based on the stock option backdating scheme and other fraudulent conduct noted above. Mercury, which was acquired by Hewlett-Packard Company on Nov. 8, 2006, after the alleged misconduct, settled the matter by agreeing to pay a $28 million penalty and to be permanently enjoined. See Litigation Release No. 20136 (May 31, 2007). On September 17, 2008, the Commission filed settled charges against three former outside directors of Mercury alleging that they recklessly approved backdated stock option grants and reviewed and signed public filings that contained materially false and misleading disclosures about the company's stock option grants and company expenses. The outside directors settled the matter by consenting to permanent injunctions and the payment by each director of a $100,000 penalty. See Litigation Release No. 20724 (Sept. 17, 2008). Mercury and the outside directors settled the charges without admitting or denying the allegations in the Commission's complaint.

The Commission's litigation against the other senior Mercury officers is continuing.

March 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Censures Cornerstone Capital Management

The SEC issued anOrder Making Findings and Imposing Remedial Sanctions Pursuant to Sections 203(e), 203(f) and 203(k) of the Investment Advisers Act of 1940 (Order) against Cornerstone Capital Management, Inc. (Cornerstone Capital), a registered investment adviser, and its sole principal, Laura Jean Kent (Kent), of Redwood City, California.  In the Order, the Commission finds that from 2003 through 2007 Cornerstone and Kent, despite knowing that the value of certain illiquid securities (also referred to as alternative private investments) in which they had invested approximately $15 million of their clients' funds were severely impaired, continued to assure their clients that the investments retained their full value. Even after the principals behind some of those investments were convicted of criminal fraud, Kent continued to charge an assets-under-management fee based on the original cost of the failed investments, collecting $335,758 in inflated fees from her clients.

Based on the foregoing, the Order finds that Cornerstone and Kent willfully violated Sections 206(1) and 206(2) of the Advisers Act, which make it unlawful to employ any device, scheme, or artifice to defraud any client or prospective client; and to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.

The Order censures Cornerstone and Kent, and requires them to cease and desist from committing or causing any violations and any future violations of Sections 206(1) and 206(2) of the Advisers Act. The Order also requires Cornerstone and Kent to disgorge improper management fees of $335,758 and prejudgment interest of $80,000, for a total of $415,758, but waives payment of such amount except for $335,758 and declines to impose a penalty based on Cornerstone's and Kent's sworn representations concerning their financial condition. The Order directs Cornerstone and Kent to pay their disgorgement quarterly over a three-year period, and also requires Respondents to develop a plan to distribute the disgorgement ordered.

In addition, the Order requires Cornerstone and Kent to comply with undertakings to retain an independent consultant to value all of Cornerstone's alternative private investments, if any, for a three-year period. Cornerstone and Kent agreed to the issuance of the Order without admitting or denying its factual findings. (Rel. IA-2855; File No. 3-13199)

March 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)